Wall Street, Gold slid on hotter than expected retail sales

On Tuesday, Fed Governor Waller sounded more hawkish than expected and after his comments, US short-term interest-rate futures imply less than a 60% chance of a Fed rate cut in March, vs more than a 70% chance seen before Fed's Waller speech. In the early Tuesday European session, US/European stock indices and Gold slipped after ECB policymakers including President Lagarde talked down an early rate cut by March’24.

On Wednesday, ECB President Lagarde said:

·         We will likely cut rates by the summer

·         We are confident inflation will reach the 2% target

·         The ECB has achieved peak rates, short of a major shock

·         Second-round effects would be cause for concern

·         We're watching wages, profit margins, energy and supply chains

·         We can't shout victory until inflation is sustainably at 2%

·         Too optimistic markets don't help the ECB's inflation fight

·         I won't comment on markets, they do their job, but Aggressive rate-cut bets don't help the ECB

·         Inflation isn't where the ECB wants it. ECB is confident inflation will reach 2% target

·         Too optimistic markets don't help the ECB's inflation fight

·         Although the ECB is on track towards the 2% inflation objective, it would be too early to declare victory until the bank can confidently sustain this level

·         We are optimistic that we have a credible prospect of a return of inflation to 2% in 2025 but a lot still needs to go well for that to happen

·         ECB is closely monitoring several economic indicators, including wages, profit margins, energy prices, and supply chain dynamics

·         ECB to keep an eye on ongoing global supply chain developments

·         The ECB is closely monitoring global supply chain dynamics as a crucial factor in the upcoming period, particularly to assess whether the ongoing disruptions in the Red Sea significantly impact goods inflation in the Eurozone. The cost of shipping a 40-ft (12.2m) equivalent container from China/East Asia to the Mediterranean has surged almost three times since the beginning of the year. This increase is attributed to attacks by Iran-backed Houthis on commercial ships, compelling them to take longer, more expensive alternate routes

·         The euro area's unemployment rate held steady at 6.4% in November, matching the record low set in June. Additionally, the third quarter witnessed a historic 5.4% year-on-year increase in wage growth, raising some warnings on second-round effects on inflation

On Wednesday, European/US stock Futures recovered from early Fed panic low as Lagarde sounded less hawkish than earlier; but stocks were also undercut on hotter-than-expected core inflation in the U.K. But eventually, Wall Street Futures stumbled on hotter than expected US retail sales, which may keep the Fed on hold till at least H1CY24 rather than any rate cuts from March’24.

On Wednesday, the CB flash data shows seasonally adjusted U.S. retail sales for Dec’23 were around $709.8904B vs. 705.981B sequentially (+0.6%) and 672.336B yearly (+5.6%); i.e. the U.S. retail sales surged +0.6% sequentially in Dec’23, against +0.3% rise in Nov’23, above market consensus +0.4% increase and the biggest monthly increase in 3-months.

The Dec’23 retail sales were boosted by autos (1.2%). Excluding autos, retail sales increased 0.4%. Sales also went up at non-store retailers (+1.5%), clothing (+1.5%), general merchandise stores (+1.3%), miscellaneous store retailers (+0.7%), building materials and garden equipment (+0.4%), sporting goods, hobby, musical instrument and books (+0.3%), and food and beverages stores (+0.2%). On the other hand, sales declined at health and personal care (-1.4%), gasoline stations (-1.3%), furniture (-1%), and electronics and appliances (-0.3%) and were unchanged at food services and drinking places. Excluding autos, gas, building materials and food services, the so-called super core retail sales rose at a strong 0.8%, the most since July. Considering the full 2023, unadjusted retail sales increased 3.2%.

Overall, the average retail sales are now around $695.422B in 2023 against the 2022 average of $672.675B, growing around +3.4% annually. The US retail sales nominal growth is still robust despite higher borrowing costs and higher cost of living as the labor market is still robust and the lagging effect of huge fiscal stimulus (COVID) is still prominent. Adjusted inflation (CPI), the underlying real retail sales has grown around +1.3% in 2023 against +1.4% in 2022 on an annualized basis. In Dec’23, the real retail sales grew around +2% after Nov’s +1% due to lower inflation and higher festival sales. Overall, U.S. real retail sales growth is moderating, but still hot enough for the Fed’s ‘higher for longer’ stance to contain inflation without causing an all-out recession (hard landing).

On Wednesday, Fed’s latest Beige book said:

·         The prospect of falling interest rates was cited by numerous contacts as a source of optimism

·         A majority of districts reported little or no change in economic activity

·         Concerns about the office market, weakening overall demand, and the 2024 political cycle were often cited as sources of economic uncertainty

·         5 Fed districts noted overall price increase had subsided from a prior period

·         6 districts noted slight or modest price increases. 2 noted moderate increases

·         Nearly all Fed districts reported cooling labor markets

·         7 districts saw little or no net change in overall employment levels, 2 described a tight labor market

·         The majority of the twelve Federal Reserve districts reported little or no change in economic activity since the prior Beige Book period

Conclusions:

Fed has to ensure a 2% price stability (core inflation) target keeping the unemployment rate below 4% and also 10Y bond yield below 5.00-4.50% so that borrowing cost for Uncle Sam remains manageable/sustainable to fund +34T debt (never-ending).

In any way, at the current run rate and trend, the average US core PCE inflation should be around +4.0% in 2023, +2.5% in 2024, +2.1% in 2025, and +1.5% in 2026, in line with Fed’s Dec’23 SEP. Similarly, the U.S. core CPI inflation average should be around +4.6% in 2023, +3.2% in 2024, +2.5% in 2025, and +1.8% in 2026.

If US core CPI indeed dips below +3.0% by May-June’24 and if it seems that the 2024 average core inflation will be around +3.2%, then the Fed may start cutting rates from July’24 and may cut cumulatively 75 bps at -0.25% pace till Dec’24 for a repo rate at 4.75%, so that core real rate continues to stand around +1.50%, in line with the present restrictive stance (5.50% repo rate-4.00% average core CPI for last 6M).

Looking ahead, the Fed may try to balance the financial/Wall Street stability and price stability by expressing intentions to cut (dovish jawboning) from Mar’24 (Q1CY24) to ensure a soft landing while bringing down inflation. Also, whatever the narrative, the Fed has to ensure lower borrowing costs for the U.S. Government (Treasury) endless deficit spending and mammoth public debt of almost $32T. The U.S. is now paying around 15% of its revenue as interest on public debt against China/EU’s 5.5%.

As a result of higher bond yields around 4.50%-5.00% (for 10Y UST); i.e. lower bond prices, the Fed is now in deep MTM loss for its huge bond holding. Fed is also providing higher interest to banks & financials for reverse repo operation than it getting under repo operation; i.e. Fed’s NIM/NII is now negative and theoretically the Fed is in negative profit to the tune of -$130B. The same is also true for various banks & financials, most of which are now in deep MTM loss for higher bond yields; i.e. lower prices for their HTM bond portfolio holdings due to Fed hikes. The US10Y TSY market price fell from around $140 to $105 from Jan’20 (pre-COVID) to mid-Oct’23; i.e. a fall of almost -33% in around 4 years; it recently recovered to almost $113 levels.

This is a red flag, and thus Fed has to operate in a balancing way while going for calibrated hiking to bring inflation down to target, avoiding an all-out recession; i.e. to ensure both price & financial stability and soft-landing. Fed has to bring down inflation to +2.0% targets by ensuring US 10Y bond yield below 4.50-5.00%, and an unemployment rate below 4.0% without triggering an all-out or even a brief recession in the US Presidential election year (Nov’24). The Fed will ensure that the US10Y bond yield is below 4.50-5.00% at any cost for lower borrowing costs for Uncle Sam (U.S.), everything being equal. Thus, overall Fed is methodically jawboning on both sides (hawkish/dovish) from time to time to achieve all its goals at the same time.

Considering all pros & cons, Fed may wait for core inflation data (average for core PCE and core CPI) for at least Dec’23-Mar’24 and if it goes down to around +4.00% from the projected 2023 average of +4.5% (4.80% core CPI and +4.20% core PCE), the Fed may cut rep rates/FFR by -25 bps in July; further if such disinflation trend continues, Fed may cut -25 bps each in September and December for a cumulative -75 bps.

We may see a synchronized global easing from H2CY24. As the Fed is the world’s unofficial central bank because the USD is the ‘King’ (the world’s most preferred FX or global reserve currency), all major G20 central banks are now bound to follow the Fed policy stance to maintain present policy/currency/bond yield parity, everything being equal.

Thus the market is now expecting a synchronized global easing (rate cuts) by major G20 global central banks including ECB, BOE, BOC, PBOC, and even India’s RBI, whatever may be the domestic macro-economic narrative (just like post-COVID synchronized global tightening to bring inflation down to targets).

Fed policymakers will now jawbone the market in a balancing way to keep the US10Y bond yield between the 3.25-5.25% range or around 4.00-4.50% on an average to maintain price/labor market/financial (Wall Street) and also Main Street/White House stability in the election year (2024). As the U.S. labor market is still robust with healthy wage growths, the incumbent Biden admin may prefer price stability and lower inflation in the coming months along with a sub/below 4% unemployment rate; i.e. price stability over GDP growths. As the 10Y bond is the main instrument for raising debt and a benchmark for US/global borrowing costs, the Fed may not allow it to hover above 5.00% for long under any circumstances, everything being equal. Fed needs to lower borrowing costs for the U.S. government from the present 15% to 10-7% over the next few years.

Fed hiked rate last in July’23 for a +5.50% repo rate and in hold mode with a hawkish stance since Aug’23; subsequently, US10Y bond yield gradually surged from around +3.75% to +5.00% by late November. As a result of higher borrowing costs and tighter financial conditions, the demand of the economy was affected to some extent, resulting in lower inflation. Now Fed has to keep on hold (neutral mode) for at least 10-12 months from July’23, so that the impact of higher borrowing costs is gradually transmitted to the real economy in full, resulting in core inflation back to targets.

Thus Fed has to wait till at least July’24 for the expected 1st rate cut; otherwise, its credibility may be at stake. If the US10Y bond yield again falls below +3.0% in the coming days (from the present +3.95%), then it may cause less restrictive financial conditions, resulting in higher core inflation. Thus Fed has to jawbone the market so that the US10Y bond yield hovers around 4.0-4.50% in the coming days so that the Fed can ensure relatively lower borrowing costs and price stability (soft landing).

Market wrap:

On Wednesday, Wall Street, Gold slid on fading hopes of an early and deeper Fed rate cut after hotter-than-expected U.S. retail sales data for December. Blue chip DJ-30 slumped -0.23%, tech-savvy NQ-100 lost -0.55%, while broader SPX-500 slid -0.55%. Wall Street was dragged by real estate, utilities, consumer discretionary, energy, materials, industrials, communication services, techs, banks & financials, healthcare, and consumer staples. On Wednesday, Alphabet, Amazon, and Nvidia lost more than -0.7%, while Tesla fell -1.2% following a reduction in prices for its Model Y cars in Germany. Apple also lost 0.5% following reports that the company will be banned from selling watches with blood oxygen sensors starting Thursday.

Technical trading levels: DJ-30, NQ-100 Future, and Gold

Whatever may be the narrative, technically Dow Future (37900), now has to sustain over 38100-38300 levels for a further rally to 38700/39000-39200/39500 levels in the coming days; otherwise, sustaining below 38050-37500-37350 levels may further fall to 37280*-37200/37000-36850/36650 and 36400/36200-36050/36000-35800*/35500 and may further fall to 35350/35250-35000/34800 and 34650/34120-34000 and 33700/33200-33000/32400 in the coming days.

Similarly, NQ-100 Future (16950) now has to sustain over 17300 for a further rally; otherwise, sustaining below 17200/17100-17000/16850 may again fall to 16550/16300-16200/16050 and 15700/15400, and further 15100-14140 in the coming days.

Also,technically Gold (XAU/USD: 2008) now has to sustain over 1992 for a rebound/rally to 2050-2085-2105/2120 and 2130/2152 levels; otherwise sustaining below 1990, may further fall to 1975-1960/1950-1928/1908 in the coming days